Indonesia's Foreign Direct Investment Jumps 21% in Second Quarter

CNBC.com

Thursday, 21 Jul 2011 | 9:15 PM ETCNBC.com

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Foreign direct investment in Indonesia surged 21 percent in the second quarter of 2011 from a year earlier, as strong commodity prices attracted investors into the mining sector in the world's top exporter of thermal coal and tin.

AP

Heavy morning traffic, Thamrin Street, Jakarta, Indonesia

Direct and portfolio investment has quickened into Southeast Asia's largest economy in recent months, though analysts warn the country needs to overhaul and expand its infrastructure in coming years to keep attracting firms and to overcome the sprawling archipelago's Achilles' heel — inflation.

For now things look rosy: FDI totals $9.6 billion so far this year, on track for its highest ever in 2011, while foreign investment in government bonds and the stock market are both at records.

"I'm very bullish," said Gita Wirjawan, the country's investment chief and a former investment banker. "Traditionally, investment quickens in the third quarter."

Worries over eurozone and U.S. debt and slower growth in China mean Indonesia is now seen as a relative safe haven, though that could change once the West recovers or if runaway inflation returns to erode a rupiah at seven-year highs .

FDI from April to June was 43.1 trillion rupiah ($5 billion), spread across the country. In a quarter when gold and tin prices hit records , mining led the way with $1.5 billion, followed by chemicals, machinery, electronics and transport.

"FDI will continue coming because of strong economic fundamentals and the appreciating rupiah...the main concern with long-term investment is poor infrastructure conditions and inflation," said Eric Sugandi, economist at Standard Chartered in Jakarta.

While inflation is within the central bank's 4-6 percent target now, economists say inflationary pressures will pick up again and lead to interest rate rises by mid-2012 that could slow growth.

Poor infrastructure, from roads to ports, means higher distribution costs that create both a structural inflation problem and cut into companies' profit margins. Previous bouts of high inflation have led to investor outflows.

The government is relying on private investors for two-thirds of its $15 billion infrastructure needs, though Japan, China and India have all made big commitments this year.

Yet progress on the ground in its traffic-logged cities and overwhelmed ports remains to be seen, while corruption is rife.

"This is still Indonesia. Everyone wants something for nothing," said the Australian manager of a road building firm.

Roads Not Supplied

Infrastructure is seen as an investment opportunity if the government can speed up land acquisition in the next year, with many investors forced to build their own roads, rail and ports.

Wirjawan did not mention specific firms, though in recent months officials and executives have said Coal India, Procter & Gamble and Hyundai Motor are planning investments, while dozens of others from Google to Peabody Energy are eyeing the country.

Neighbouring Singapore, a home for many Indonesian tycoons, was the top foreign investor in Q2, followed by former colonial ruler the Netherlands and then the United States, underlining growing interest from Western investors who in recent years lagged Asian firms because of worries over corruption.

South Korea and India are expected to be leading investors in the future, the investment agency said, with LG Electronics eyeing expansion to tap consumer demand from an emerging middle class in the world's fourth largest population.

India's state-run National Aluminium Co Ltd (NALCO) is in talks to invest in an aluminium smelter, the investment agency said on Thursday, joining other Indian firms looking to buy coal mines and develop power or cement plants.

The investment board is targeting 156 trillion rupiah of FDI this year. Last year foreign investment into Indonesia reached a record 148 trillion rupiah.

External Risks

Analysts say the country ticks along at 6 percent annual economic growth despite the government and shabby bureaucracy .

Fitch Ratings said in March it could lift Indonesia's sovereign rating to investment grade within 12 months, though weak infrastructure was the key risk to any upgrade.

"A lack of infrastructure remains one of the biggest constraints to boosting Indonesia's growth potential. Significant improvements to the regulatory framework are needed to support infrastructure spending and public-private projects," said Milan Zavadjil, the IMF's representative in Indonesia, adding it had to overcome inflation from cutting fuel subsidies.

Still, compared to much of the world, Indonesia's financial situation looks strong, with a budget deficit seen at 2.1 percent of GDP this year, and record foreign currency reserves of about $120 billion to stabilise the rupiah currency in the event of any sudden fund outflows.

Economists say this could happen once a global economic recovery leads Western countries to start normalising rates.

"We see fears from investors from the end of the low interest rate era in countries such as the United States, Europe, and Japan. Once the Fed increases its benchmark... a large sudden reversal might occur in the Asia region," said Juniman, an economist at Bank International Indonesia in Jakarta.

"Another risk is the threat from a sovereign debt default in Europe and that it could spread to the U.S. That will cause global economic instability and the world will fall into recession, eventually. FDI would stop, to wait and see."

Options Action

The Reserve Bank of Australia indicates that it could put rates on hold for the time being and will only opt for further rate cuts, if necessary, says Sean Callow, senior currency strategist at Westpac.